**1. Introduction**

Economic uncertainty, in a broad sense, is defined as the situation where future outlook for the economy is unpredictable. In case of rising uncertainty, agents in the economy are negatively affected because their expectations are blurred and they are not able to foresee the consequences of their decisions. For instance, consumers having uncertain expectations about their future income stream would prefer to postpone their consumption today and save more in order to obtain smooth path of lifetime consumption. This behavior, named as precautionary saving motive [1, 2], may dampen economic activity and aggregate demand in the economy in the short run [3]. Governments' public policy decisions are also influenced, but in this case, they are generally in the role of alleviating the negative impact of diminishing economic activity due to rising uncertainty [4]. They enact countercyclical policies such as fiscal expansion, tax cuts, or social transfers when uncertainty rises [5].

Firms' investment decisions are also impacted by the economic uncertainty. If uncertainty rises in an economy, firms wishing to make investment today may need to delay their decision because they become unsure about whether the future cash

flows of the firm will cover the cost of the investment [6, 7]. This situation will indirectly affect other decisions of the firms such as employment, credit usage, debt repayments, social insurance payments, and other factors. In addition to all these factors, it is inevitable that firms' balance sheet structure and ratios are also affected by uncertainty in an economy. In case of elevated uncertainty, since consumption is postponed, firms' net sales decline, and this negatively influences their profitability ratios. Furthermore, firms' indebtedness might decline because their investment is also postponed and they no longer need to borrow to finance their investment. Firms' cash holdings and liquidity ratios might improve, as they want to stay highly liquid against any negative shocks under rising uncertainty. Last but not least, firms' cost of finance and interest expenses may be negatively affected, as heightening uncertainty might lead to an increase in risk premium and depreciation in the currency where the firms' borrowing is denominated in. All these channels, and possibly more than these, explain the transmission between economic uncertainty and firm balance sheet performance. Motivating from these verities, the main objective of this chapter is to empirically analyze the impact of economic uncertainty on firms' balance sheet performance using the financial statements of real sector firms quoted in Borsa İstanbul.

There is a wide range of literature on the relationship between firm balance sheet performance and overall macroeconomic dynamics for different countries. For instance [8] analyzes the implications of macroeconomic instabilities and institutional factors on the financial distress of Chinese-listed companies. [9] assesses the influence of macroeconomic conditions on the debt currency composition of firms in Brazil and how exchange rate movements impact the balance sheets and investment decisions of firms. In a cross-country setting, [10] questions whether the use of macroeconomic and industrial indicators improves the performance measures of solvent and insolvent firms. Finally, [11] deals with the balance sheet impact of foreign currency debt and exchange rate depreciation on the investments of firms in Korea.

In addition, there is a huge literature dealing with the impact of uncertainty on overall economy as well as other dimensions of the economy. One strand of the literature investigates directly the possible influence of uncertainty shocks on economic activity and finds out that uncertainty negatively impacts the aggregate demand [12–16]. Another strand of the literature looks at the issue by empirically analyzing how uncertainty impacts the households' consumption [17–19]. There are also many studies analyzing the implications of uncertainty with firms' perspectives. Although the majority looks at the effect of uncertainty on firms' investment decisions [20–24], some studies focus on the impact of uncertainty on firms' balance sheets. Nguyen, Kim, and Papanastassiou [25] investigate the link between economic policy uncertainty and financial derivative usage of firms in East Asia and find that as uncertainty accelerates, firms use derivative instruments extensively to hedge their risks. Hankins et al. [26] document the relationship between political uncertainty and corporate cash holdings of the US firms and finds out that following an uncertainty shock, cash accounts increase and capital spending declines. A similar study by Feng, Lo, and Chan [27] on Chinese firms claims that firms with higher firm value increase their cash holdings more than other firms as economic policy uncertainty heightens. In their cross-country study with firm-level data set, Gungoraydınoğlu, Çolak, and Öztekin [28] report that firm leverage drops in the wake of rising political uncertainty. In their study on US public corporates, Tran and Phan [29] obtain that policy uncertainty is positively related to the cost of debt and negatively related to maturity of debt. Francis, Hasan, and Zhu [30] find that rising political uncertainty increases the borrowing costs of nonfinancial firms. Iqbal, Gan, and Nadeem [31] document that economic policy uncertainty adversely affects firms' performance proxied by return on equity, return on assets, net profit margin, and Tobin's Q.

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*The Relationship between Economic Uncertainty and Firms' Balance Sheet Strength*

The common point of the abovementioned firm-level studies is that they look at the impact of uncertainty on a univariate balance sheet indicator or a single aspect of firm performance. Nevertheless, so far no study deals with the link between uncertainty and overall firm performance measured by a multivariate indicator. In this respect, our study introduces a novel approach by analyzing the impact of uncertainty on a multivariate composite indicator produced from firms' balance sheets. There are several composite indicators suggested by the literature to measure the overall firm performance [32–35]. However, these indicators were mostly designed for the listed firms in developed countries and may not be appropriate for measuring the performance of Turkish firms. Hence, in this study, MFA score developed by Çolak [36] using the data of Borsa İstanbul firms is used as a more accurate indicator since it captures the distinctive characteristics of

Additionally, in investigating the association between firm performance and uncertainty, another important issue is the type of uncertainty examined. In the literature, numbers of uncertainty measures are created, such as political, trade, fiscal policy, monetary policy, financial, news uncertainties, and many more [5, 37–40]. In our chapter, our main concern is the overall economic uncertainty, consumer, financial, and trade uncertainties since we believe these factors are directly related

The chapter is structured as follows: after introduction, we will explain the details of the data set we exploited and methodology used in our analyses. In the third section, we will explain our main results. And finally, we will provide con-

Our sample consists of the financial statements of 417 nonfinancial firms quoted in Borsa İstanbul between 2005Q1 and 2019Q1 at a quarterly frequency. This corresponds to, on average, 300 firm observations each quarter and 13,356 unique observations in total. Real sector firms are obtained by eliminating the financial sector firms, sport companies, and real estate investment funds from the population of BIST firms. Quarterly income statement items are annualized by aggregating the

Initially, we measure balance sheet strength of the listed real sector firms in Borsa İstanbul (BIST) with a composite index called Multivariate Firm Assessment Score (MFA score) which combines different corporate finance ratios such as liquidity, leverage, and profitability. This index which have a 90 percent predictive power improves Altman Z-score [32] methodology for Turkish firms. Specifically, using the multivariate discriminant analysis (MDA) methodology for the seven financial ratios explained in **Table 1**, we obtain MFA score for each firm in

Later on, we removed the firms with MFA scores above the 95th percentile and below the 5th percentile in the entire sample, in order to eliminate the outlier observations. Finally, we take the average of MFA scores and obtain mean MFA scores for each quarter. The descriptive statistics of the ratios in the MFA score and MFA score

In the analysis, we consider four uncertainty indices: economic uncertainty, financial uncertainty, and consumer uncertainty indices which are developed by Sahinoz and Cosar [5], and trade uncertainty index for the Turkish economy from Ahir, Bloom and Furceri [41]. Consumer uncertainty index is a survey indicator which shows the uncertainty perception of consumers in the economy, while

*DOI: http://dx.doi.org/10.5772/intechopen.91860*

Turkish firms.

to firms' balance sheets.

**2. Data and methodology**

cluding remarks.

latest four quarters.

the sample.

itself is provided in **Table 2**.

#### *The Relationship between Economic Uncertainty and Firms' Balance Sheet Strength DOI: http://dx.doi.org/10.5772/intechopen.91860*

The common point of the abovementioned firm-level studies is that they look at the impact of uncertainty on a univariate balance sheet indicator or a single aspect of firm performance. Nevertheless, so far no study deals with the link between uncertainty and overall firm performance measured by a multivariate indicator. In this respect, our study introduces a novel approach by analyzing the impact of uncertainty on a multivariate composite indicator produced from firms' balance sheets. There are several composite indicators suggested by the literature to measure the overall firm performance [32–35]. However, these indicators were mostly designed for the listed firms in developed countries and may not be appropriate for measuring the performance of Turkish firms. Hence, in this study, MFA score developed by Çolak [36] using the data of Borsa İstanbul firms is used as a more accurate indicator since it captures the distinctive characteristics of Turkish firms.

Additionally, in investigating the association between firm performance and uncertainty, another important issue is the type of uncertainty examined. In the literature, numbers of uncertainty measures are created, such as political, trade, fiscal policy, monetary policy, financial, news uncertainties, and many more [5, 37–40]. In our chapter, our main concern is the overall economic uncertainty, consumer, financial, and trade uncertainties since we believe these factors are directly related to firms' balance sheets.

The chapter is structured as follows: after introduction, we will explain the details of the data set we exploited and methodology used in our analyses. In the third section, we will explain our main results. And finally, we will provide concluding remarks.
